REAL ESTATE CORNER
Two Important Court Decisions on Condos and Co-ops
By John Gordon, Esq.
1. Co-ops and the Alternative Minimum Tax
Most homeowners know that payments made toward mortgage interest and property taxes are deductible on an income tax return. Likewise, co-op shareholders can deduct mortgage interest paid and the portion, on a per-share basis, of their maintenance applied towards property taxes and mortgage interest payments for the building.
However, when computing the Alternative Minimum Tax ("AMT"), which denies some types of deductions to certain people with high incomes, a homeowner must add back the deductions taken for property taxes. Until a Federal appellate court decision, co-op shareholders were not adding back such deductions in computing their AMT. That, however, has changed.
The case, Ostrow v. Commissioner of Internal Revenue, was originally decided by the United States Tax Court and affirmed by the Second Circuit Court of Appeals. Both opinions describe the legislative intent of the tax law on this subject. Originally, co-op shareholders could not deduct their real property taxes at all, because they did not pay them directly. In that regard, they were not deemed to be "taxpayers" within the meaning of the prior law. A subsequent change in the law put co-op shareholders on an even keel with homeowners and permitted them to deduct their proportionate share of a co-op's property taxes. In the same vein, the courts in Ostrow held that it would be against the purpose of the law if co-op shareholders were allowed to use this deduction for calculating the AMT that homeowners are not allowed to use.
While this decision may not effect everyone, it could spell big problems for thousands of co-op shareholders subject to the AMT if the IRS decides to re-open their income tax returns and finds that they deducted their property taxes. The plaintiffs in Ostrow were disallowed a deduction of $10,489.00, a substantial amount of money. With interest and penalties, there could be significant sums of money due to the IRS from some co-op shareholders. Clearly, you should consult with your accountant or attorney if you believe that you may be affected by these decisions.
2. Do Condominiums Have the Right to Place Restrictions on Sales?
A decision by the Appellate Division, First Department, could drastically change the rules for condominiums. Generally, a condominium is prohibited from making rules that place unreasonable restrictions on sales. This is referred to as an "unreasonable restraint on alienation." This concept is ages old and began as a response to landowners putting very restrictive terms into deeds. Co-ops, on the other hand, are exempt from this prohibition because the actual property owned is shares of stock, not real estate.
Condominium managing boards have long enjoyed certain rights such as the right to bar unit owners from leasing their units. Boards have also been allowed to exercise a right of first refusal with respect to sales. The decision in Demchick v. 90 East End Avenue Condominium, however, apparently represents a significant expansion of a condominium board's authority to impose restrictions on sales. In Demchick, a condominium apartment building had certain studio apartments that were intended to be occupied by the condominium unit owners' household employees. The board passed a by-law amendment that restricted the sales of studio apartments to anybody other than a current owner of another apartment in the building. The Appellate Division ruled that this was not an unreasonable restraint on the alienation of real property, and reversed the trial court's decision to strike the amendment to the by-laws.
While there are some parts of the decision which suggest that it might be limited to the facts of the case, it nevertheless creates a slippery slope. Indeed, the court found that the restriction had a reasonable purpose, namely "to preserve the character of the Condominium." Therefore, the decision suggests that like co-op boards, condominium boards now enjoy similar rights with respect to imposing restrictions on sales. However, it bears noting that such restrictions will be enforceable only if they are deemed to be "reasonable". As to what restrictions are "reasonable" awaits future court rulings.